Semiconductor opportunities and challenges in the eyes of 195 executives

Latest update time：2020-04-23

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Editor's Note

At the beginning, we must state that this report should have been made by KPMG before the black swan of the epidemic, so the outlook for semiconductors in 2020 in the first part of the article is not consistent with the current situation. However, considering that this report is the result of their survey of 195 semiconductor industry executives representing global semiconductor companies and suppliers, Semiconductor Industry Observation is still translated and shared with readers. I hope to present to you the original outlook and future expectations of semiconductors in 2020 from semiconductor industry experts, which can give you some reference.

Semiconductor leaders remain optimistic despite earnings decline

Despite a decline in semiconductor industry revenue in 2019 and the continued presence of new tariffs, semiconductor leaders are optimistic about their companies’ performance in 2020. This year’s Semiconductor Industry Confidence Index score is 59, which is based on respondents’ outlook for annual changes in company revenue, operating margins, headcount, capital expenditures, and research and development spending.

(Semiconductor Industry Confidence Index)

The industry’s optimism is not blind, but a recognition that the memory industry’s poor performance in 2019 was due to falling prices – a major factor in the industry’s sluggish performance in 2019. Excluding memory, the overall semiconductor market performance was relatively flat.

KPMG's survey shows that large companies with revenues of $1 billion or more and related to the hard-hit storage industry say the trough of the cycle is in the past. They see excess storage products being absorbed by the market, are confident that the storage industry will rebound in 2020, and even see future growth, although the growth rate will not be as rapid as that of smaller competitors. These traditional global semiconductor companies are more diversified in slower-growing industries and are more vulnerable to global economic headwinds - all factors that may lower their expectations for the coming year.

Meanwhile, smaller companies with revenues below $100 million were never really threatened in 2019. Often, the prospects of scaling technology to smaller, shared applications are not affected by the slowdown in revenue growth across the industry. In fact, smaller companies are particularly confident about their prospects. These newer market players are generally more inclined toward innovative chip applications such as the Internet of Things (IoT), artificial intelligence (AI), 5G, and faster-growing industries such as automotive and communications.

(Confidence Index by Company Revenue)

The outlook for revenue growth in 2020 is particularly healthy for chipmakers large and small. Nearly nine in ten (89%) semiconductor executives expect their companies’ revenues to grow over the next year as the economy fully recovers and prices recover. The magnitude of the expected revenue growth is also important. Across all companies, 74% of respondents expect their companies’ annual revenues to increase by 6% or more. Among small companies in high-growth mode, 58% of respondents predict revenue growth of more than 20% in 2020.

As the memory product glut repairs itself and demand picks up, semiconductor companies are increasingly confident that the industry will recover and are ready to capitalize. Most companies plan to invest in equipment, software and labor to help drive their 2020 revenue growth. Nearly six in ten chipmakers (59%) plan to increase capital expenditures, and about three-quarters (73%) plan to expand their workforce. And, with price erosion no longer a major issue, annual operating profit expectations are also largely positive.

“While demand for memory drove a historic 2018, oversupply caused it to collapse in 2019,” said Lincoln Clark, partner in charge of KPMG’s global semiconductor practice. “But this is a mature industry with applications in nearly every sector of the global economy. It is already rebuilding on a solid foundation. As uncertainty abates, chipmakers and suppliers are preparing to return to growth mode.”

Key points:

Most people believe that 2019 is just a blip in the industry's long-term performance. Growth is expected in 2020 due to a correction in the storage market.
Take advantage of the economic recovery and invest strategically in equipment, technology and talent to maximize growth opportunities.

R&D efficiency represents a billion-dollar opportunity

In the rapidly evolving semiconductor industry, access to the latest materials, technologies, chip designs and manufacturing processes has always been the basis of competition. However, in today's highly connected world, R&D is more important than ever, and the expenditure is greater.

First, chipmakers are faced with increasingly complex applications and end markets to support. Second, technology platform companies are now designing their own chips in-house, which poses a challenge to traditional semiconductor companies, which also requires traditional semiconductor companies to provide diversified products and services. Third, the incremental cost of executing innovation (including hiring and retaining talent and developing specialized software) is rising, which requires companies to use higher levels of R&D investment to achieve the same goals and forces chipmakers to invest more in fewer designs.

With market forces at work, it’s no surprise that the world is spending huge amounts on R&D. This figure reached a record high of $64 billion in 2018 and continued to grow in 2019. The KPMG survey also found that semiconductor industry leaders expect to make large-scale R&D investments in 2020. Nearly three-quarters (73%) of respondents said their companies plan to increase R&D spending in the next fiscal year, and 27% expect to increase by more than 10%.

But will increased R&D spending generate the expected benefits? This may not be the case for everyone. There is still a lot of room for improvement in R&D efficiency. According to KPMG's survey, 9% of R&D spending is not effectively aligned with market opportunities. Another 32% is also under investigation, because these products and programs under investigation may never enter the market. This also means that R&D efficiency has dropped another step since the 2018 survey.

Of course, a certain amount of R&D waste is to be expected and even accepted. Like all creative endeavors, innovation always involves a degree of risk. Not every idea will receive adequate funding. Not every innovation will make it into the product portfolio. Not every new product will live up to its market potential. And every semiconductor company, no matter how sophisticated it is in R&D, will experience some failures.

Still, R&D missteps can’t offset successes. The risk of wasted R&D dollars only grows as spending increases, easily running into billions, if not tens of billions. Chipmakers need to spend more efficiently on R&D. They also need to get more efficient at turning R&D into results. This is a multi-billion dollar opportunity.

(Change in semiconductor company R&D spending for the next fiscal year compared to the current year)

(Efficiency of combining R&D expenditure with market opportunities)

Agile portfolio management could be a game changer for semiconductor companies looking to improve their R&D processes, increase returns on innovation, and reduce R&D risks. In a rapidly changing industry, facing market disruptions and fierce competition, traditional methods of prioritizing and funding business initiatives (such as annual planning and R&D budgets) will not be effective. Chipmakers need agile processes to identify the products with the greatest potential among ongoing and proposed projects and allocate resources to them.

Applying agile principles to project portfolio management enables chipmakers to quickly reevaluate and reprioritize projects based on changing market conditions and customer needs. They can then take advantage of emerging opportunities and increase speed to market. Agile portfolio management also improves visibility into the innovation pipeline, helping chipmakers understand when to cut hopeless projects and reallocate resources to the next highest value projects.

As semiconductor R&D costs rise, leveraging data and analytics (D&A) in the R&D process will also help chipmakers optimize R&D, improve return on investment (ROI) and bring more profitable products to market faster. D&A capabilities are a fundamental component of agile project portfolio management, helping different product design teams to discover and share information hidden in large amounts of data, thereby improving productivity and shortening the entire design lifecycle.

“Improving R&D efficiency will differentiate the semiconductor business,” said Scott Jones, global semiconductor practice leader at accounting firm KPMG. “But be careful not to stifle all risk-taking. Achieving perfect alignment is likely a sign that leadership is too focused on meeting known market needs and not thinking deeply enough about new prospects that could enable the company to achieve long-term growth.”

Key points:

As R&D spending increases, the risk of wasted R&D dollars will only grow, easily running into the billions of dollars.
Use R&D budgets effectively, adopt agile portfolio management, help align new innovations with emerging market needs, and allocate resources to the greatest potential opportunities.

Changes in global trade bring opportunities

Chris Gentle, partner in KPMG's global semiconductor practice: "The current global trade environment represents a potential source of savings to rethink tariff mitigation strategies and optimize global supply chains."

The current “me-first” trade environment poses a serious challenge to the global semiconductor industry, and the increase in global tariffs and trade protectionism may continue to be unfavorable for semiconductor companies to achieve the revenue growth expected in 2020. Managing the sudden emergence of new trade costs is a top concern for business leaders.

U.S. tariffs are at the heart of global trade issues. Since 2018, the United States has imposed multiple rounds of tariffs on billions of dollars worth of imports to correct perceived unfair trade practices, prevent intellectual property theft, and protect U.S. industry and national security. The tariffs apply to a wide range of industrial materials and products commonly found in end products such as semiconductor chips and electronics and automobiles, and will range from 7.5% to 50% depending on the product category.

Tariff barriers add to cost pressures

Most of the U.S. tariffs target imports originating from China, leading to China imposing retaliatory tariffs on U.S. exports and further complicating the semiconductor industry’s trade relationship with China. Tariffs on imported and exported components directly affect chip manufacturing costs. According to a survey by accounting firm KPMG, two-thirds (67%) of semiconductor companies will pass on some or all of the tariff costs to customers.

Larger chipmakers with revenues of more than $1 billion are more likely to pass on tariff costs. With higher overall volumes and more global supply chain operations, large companies typically bear a large portion of tariff liability. They are also more likely to be public and under pressure from shareholders to deliver healthy quarterly returns, making it more imperative that they quickly recoup tariff costs. In addition, large chipmakers’ market share, design advantages and strong customer relationships give them pricing power, reducing the risk associated with price increases from customers.

Meanwhile, smaller companies with less than $100 million in revenue appear more reluctant to pass tariff costs on to customers. These companies ship fewer products through fewer suppliers and may currently source goods in countries that aren’t affected by tariffs today, so they may not be exposed to many additional costs. In addition, many of the products are often not fully established yet and must compete with larger ones based on price. As a result, they may consider raising prices a last resort.

Supply chain impact

Tariffs are not just a financial issue. They also introduce significant complexity to numerous processes throughout the supply chain, from inventory planning to logistics to customs clearance and compliance. To mitigate risk, 58% of semiconductor companies are considering some kind of operational response. Significant planning will take place in new regions not impacted by tariffs, including finding new suppliers and establishing incremental production and assembly lines in sourcing locations outside of those impacted by tariffs.

Large chipmakers appear more likely to make significant operational changes. With global operations and facilities around the world, they can mitigate tariff impacts without abandoning current operations. Instead, they can also recalibrate import balances from sourcing options already available. For smaller companies without established global supply chains, it is more difficult and costly to move manufacturing out of China and other affected regions. They are less likely to make operational changes in response to tariff activity.

Other tariff reduction strategies

One thing that seems certain is that tariff risk will continue to exist. While broader trade negotiations are still ongoing, a trade solution does not appear to be complete, and chipmakers must act quickly to adapt to this changing landscape.

The benefits of implementing tariff mitigation measures can be huge. KPMG surveyed more than 100 trade and operations executives from various industries, and the results showed that companies that implemented strategic tariff reduction plans can save an average of 59% of tariffs on the United States. Optimized supply chains can reduce other costs and operating expenses in addition to tariffs.

Origin Adjustment

One way semiconductor companies can reduce tariff costs without significantly disrupting their business is to strategically relocate operations in a piecemeal fashion. Many semiconductor companies see Taiwan, Vietnam, Malaysia, the Philippines, and other lower-cost Asian manufacturing locations as alternatives to China, but they also acknowledge that no single location can match China in terms of capacity and manufacturing processes. Other countries are adopting dual and multi-origin strategies that provide the flexibility to ship to a variety of markets from different locations, depending on current tariffs, free trade, and geographic factors.

However, in many cases, it is possible to move certain steps in the manufacturing process away from China to lower-cost manufacturing locations and still result in a non-China-sourced product. Similarly, in some cases, sourcing one or more key components from a non-China country while retaining assembly or test operations in China may be sufficient to result in a non-China-origin product. The origin of U.S. imports is determined on a case-by-case basis based on a detailed review of the relevant facts and circumstances, and tariff mitigation strategies that involve partial adjustments to product sourcing or manufacturing should be carefully reviewed before making significant investments.

Remove products from tariff lists

Another way semiconductor companies can reduce their tariff liability is to request an exclusion from the tariffs. Exclusions can be granted on three main bases: (1) the tariffs will cause severe financial harm to the importer or other downstream interests in the United States; (2) the product outside of China does not provide adequate performance or quality; or (3) the product is not relevant to China’s “Made in China 2025” industrial plan. The tariff exclusion process is complex—exclusion requests must be made on a product by-product basis, and authorities require detailed harm justification—but once an exclusion is granted, the potential benefits can be substantial. Importantly, importers granted an exclusion can apply the exclusion to prospective imports and use it as a basis to recover tariffs that have already been paid since the tariffs took effect.

Impairment plan

Since most tariffs are levied on an ad valorem basis, importers may also consider reducing the value of their imports, thereby reducing their overall tariff liability. It is recommended that existing product pricing and payment structures be reviewed and, in some cases, the use of existing programs, such as the Export First Sale Program, which allows importers to report the “first sale” price of imported items as the customs value, which may result in significant savings.

Tax Refund

Finally, the Duty Drawback program can recover up to 99% of the tariffs paid on qualifying merchandise for products destroyed in the United States, products used in U.S. manufacturing operations, or any products imported into the United States and then re-exported abroad. Due to recent regulatory changes, the Duty Drawback program is easier to use than ever before. In today's tariff environment, many importers who were previously unconcerned about managing tariffs are surprised to discover that they have a wealth of cost-saving opportunities.

Export Control Statement

In addition to tariffs, U.S. authorities continue to take steps to further restrict U.S. chipmakers (and other companies) from doing business with China. Recently implemented policies include sanctions on business with specific Chinese technology companies (e.g., Huawei and ZTE8), increased government scrutiny of visa applications and license authorizations necessary to employ foreign talent, and steps to expand U.S. jurisdiction over foreign-made products that incorporate U.S.-origin technology. These actions are impacting the semiconductor industry’s ability to conduct business efficiently, not just in China, but in markets around the world. In the face of these challenges, semiconductor companies must truly understand their supply chain and sourcing strategies as they exist today and as the opportunities for tomorrow, so they can quickly respond to a rapidly changing global trade environment.

Key Takeaways – Managing Tariff Costs

As countries become more concerned about protecting their industries, the trend toward removing tariffs has reversed. As tariff disputes escalate, companies may be left in the lurch, increasing costs. Here are some strategies for managing the impact.

Short-term strategy

Some leading companies are embracing southward migration from China, even overland shipping options. Others are adopting dual and multi-sourcing strategies that provide the flexibility to access a variety of markets from different locations, depending on current tariffs, free trade, and geography.
More than 50 methods are available to mitigate or recover the costs of the new tariffs. These include duty waivers and reclassifications, customs valuation programs, and duty deferral and drawback programs.

By bringing together product designers and supply chain and global trade experts, companies can ensure that the products they produce are protected from tariffs in the short term.
KPMG research shows that companies that actively seek to mitigate the impact of tariffs can reduce their tariff burden by an average of 58%, depending on the industry and the company's willingness to improve business processes.

Long-term strategy

Companies can prepare for the new strategic and operational challenges they may face in the coming decades by:

Integrate corporate risk assessment with daily operations to ensure that the company's strategic planning is consistent with local policies and their possible impacts.
Use scenario planning to assess the likely impacts of these policies and determine the best options now and in the future.
Understand customer, supplier and competitor behavior to help ensure your cost structure and supply chain remain superior to the market.
Policies that ensure the company’s approach to trade compliance and cost issues is consistent with its tax responsibilities and social contributions to the countries in which it operates.
Establish strong governance for global trade management, including policies, minimum standards, global business processes, standard documentation, performance tracking and reporting processes.

By investing in flexible supply chain strategies and a strong global trade management infrastructure, and basing their strategies on solid scenario planning, companies can enhance their competitive advantage no matter what the future holds.

5G, IoT, AI and automotive applications lead the way

Technological developments have expanded opportunities for the semiconductor ecosystem and created new revenue streams. Now, technological convergence is poised to propel the industry to even greater scale.

According to the survey results, semiconductor executives believe that wireless communications (including 5G), the Internet of Things (IoT), and automotive applications offer the greatest promise for future semiconductor revenue growth. As these technologies evolve, they will converge into individual systems and devices that all require advanced semiconductor content.

Wireless communications and the Internet of Things are the most important applications driving revenue growth in the next fiscal year, followed by automotive and artificial intelligence (AI). The same applications for semiconductor products also occupied the top four positions in last year's survey - this is the first year that the Internet of Things is as important as wireless technology.

Wireless technologies once again top the list in this year’s survey by a small margin. While the wireless communications landscape is broad and many legacy technologies will be maintained in the near term, the change in rankings can be attributed to the actual and ongoing launch of 5G global networks that we saw in 2019 and will continue in 2020.

Although campus and city-wide deployments have begun, 5G has not yet reached scale. Respondents said the cost of building a network is the No. 1 barrier, followed by the time it takes to build a network. The demand side is also largely unproven. There are currently few 5G-enabled products on the market, and operators are still building enterprise and consumer use cases. Still, the semiconductor industry is confident about the prospects for 5G. 50% of respondents expect 5G to be a significant driver of revenue growth for the semiconductor industry within 2 years, and it is expected to continue until the mid-2020s as widespread coverage is established in many developed countries.

The rise of 5G will in turn drive the expansion of new IoT applications that rely on 5G, including self-driving cars. While 3G and 4G were designed to bring data capabilities to smartphones, 5G is actually about powering other high-tech devices at the consumer and enterprise levels. Therefore, the development and promotion of 5G networks is crucial for the development of other promising fields, which will lead to a surge in demand for increasingly powerful chips.

“The expansion of a hyper-connected world, with semiconductors as its backbone, has created countless opportunities for the industry. Semiconductor executives see strong potential in developing chips and software that can serve both industrial and consumer markets.”

——Lincoln Clark

KPMG (USA)

Global Semiconductor Business Leader

Key points:

The convergence and interaction of technologies in new and innovative ways is creating new opportunities and business models for the semiconductor industry.
Software for synchronizing devices and systems, and new analytical tools for sorting and mining data, are opening up new opportunities for semiconductor companies looking to diversify their revenue streams.

How important are each of the following applications in driving your company's semiconductor revenue streams for the current fiscal year?

1 = not important at all, 5 = very important.

Source: KPMG Global Semiconductor Industry Survey 2020

When will 5G communication technology become a major driver of revenue growth in the semiconductor industry?

The automotive industry moved up from fourth to third place as a driver of semiconductor revenue. The automotive industry is producing increasingly advanced vehicles and mobility business models, including connected, electric and autonomous vehicles. These supercomputers on wheels are powered by electronics and semiconductors. KPMG estimates that demand for in-vehicle chips alone could drive automotive semiconductor sales to $200 billion by 2040.

AI ranked lower than automotive in the survey results, but it is still an attractive market for semiconductor products. Analysts agree that AI is a major driver of the future. IDC predicts that by 2024, AI will be integrated into every part of the business and will expand 50% of all customer interactions. IDC also expects that by 2023, 70% of IoT deployments will include AI solutions for autonomous or edge decision-making.

Tech giants such as Intel, Micron Technology and Qualcomm have recently acquired a number of AI startups and incorporated their intellectual property into their portfolios. As fewer companies begin to dominate the field, AI will continue to be an important application for semiconductor companies, but fewer companies will be able to get a piece of the pie.

From a product category perspective, sensors/MEMS (high-volume products that directly support the massive IoT market and are essential to the future automotive industry) remain the main product category driving the semiconductor industry. While addressing the global oversupply problem, respondents see lower growth opportunities for the memory industry next year.

“The pervasive smart technologies in consumer, industrial, and infrastructure applications are triggering a multiplier effect for semiconductor growth. The requirements for real-time and decentralized sensing, processing, and communications are converging in semiconductor technologies such as 5G, IoT, AI, and cloud edge computing. The interdependence and interaction of these technologies are expected to boost their market prospects individually and collectively in 2020 and beyond.”

—— President and Executive Director of GSA Globalvice

Shrikant Lokohare

Standards will open up new growth

Semiconductor executives are confident that chip demand will increase as new technologies emerge. But the path forward is not without obstacles. One of the most important issues is the lack of standards and regulations governing the development and operation of new technologies.

Semiconductor companies rely on manufacturers’ technical specifications to produce their products. But the applications of emerging technologies are often uncertain and constantly changing. Manufacturers are investing money, but they must proceed with caution until standards are formalized and it becomes clear which products will be accepted and used. Ordering parts in bulk that may soon fail to meet requirements is a significant risk that most manufacturers avoid. In this way, standards and regulations help open up new markets and drive demand for specialized semiconductor content to support those markets.

Semiconductor leaders who responded to our survey believe that common standards and regulations will most help drive semiconductor growth in three areas: 5G, IoT, and autonomous vehicles.

In which area will common standards and regulations help drive the greatest growth for semiconductor companies?

Formal standards will help the semiconductor industry realize the full potential of emerging technologies. These will accelerate the design and manufacturing process, speed up interoperability, and facilitate the creation of new business models. - Chris Gentle, Partner, KPMG Global Semiconductor Practice (US)

standard

5G: 5G received the most responses, likely due to its near-term nature. Today, there are many flavors of 5G, ranging from low-band to ultra-high frequency bands depending on the operator's strategy and licensing portfolio. 5G is already here, but for it to really take off, operators will greatly benefit from baseline standards that regulate the market. The United States, China, and other countries are currently developing 5G standards for frequency, bandwidth, range, device communication and interaction, and device security. By understanding the technical characteristics required to qualify for 5G spectrum use, operators can make more strategic decisions about their 5G business. As the 5G market matures and grows, the semiconductor industry will benefit from increased demand for chips manufactured and optimized for it.

Internet of Things: Similarly, as connected device manufacturers gain more information about product specifications, the already large IoT market will open up further. Security and privacy are key regulatory focuses for IoT. Insecure IoT devices can compromise the health and privacy of consumers and businesses. IDC predicts that by 2023, 1 in 5 cybersecurity incidents will come from the deployment of IoT devices in smart cities. Today, governments around the world are developing rules to set minimum reasonable security and privacy standards for IoT products. In addition, some manufacturing sub-sectors are regulating themselves by creating best practices and other guidelines for security and privacy of connected devices. Although the regulatory pipeline is changing rapidly, manufacturers are increasingly able to understand what "good" looks like and create products that are not only likely to be universally compatible, but will also win the trust of consumers. As the market continues to expand, chip orders are likely to follow suit.

Autonomous Vehicles: Safety standards will also be a key factor in the development and commercialization of fully autonomous vehicles. Respondents cited this as the number one factor in the widespread adoption of driverless cars. At the broadest level, regulations are needed: dictating what types of vehicles can operate where. To ensure the safety and reliability of the autonomous ecosystem, baseline standards must be established for sensors and other advanced computing products used extensively in vehicles, smart city infrastructure, and 5G communications networks. Unless universal “rules of the road” are developed, the deployment of autonomous vehicles will pose too great a risk to manufacturers and consumers, and semiconductor chip orders will only reach a fraction of their potential.

“Autonomy still plays a minor role in the overall automotive industry, but this is expected to change as regulation is introduced. Our forecast for demand for autonomous (and electric) vehicles through 2040 sees annual growth in automotive semiconductor sales of 7.7%.

—Scott Jones

KPMG Global Semiconductor Practice Leader (USA)

Key Takeaways:

Common standards and regulations for new technologies would be a boon to semiconductor companies, allowing them to make their production processes more efficient.
Standards such as 5G, the Internet of Things, and self-driving cars will be most beneficial to semiconductor companies.

Different node sizes still come into play

With so many different types of products needed from semiconductor companies, from simple sensors to advanced AI chips, it’s no surprise that many different node sizes are still being used, with large semiconductor companies often producing chipsets across the entire size range. Respondents responded that their products are being labeled at the following node sizes.

At which technology node are your company's products launched?

Innovation is more important than ever

Innovation and expansion of R&D are the top strategic goals for semiconductor companies over the next three years, with more than half of respondents listing it as one of their top three priorities, up 10 percentage points from last year’s survey.

As semiconductor applications and end markets diversify, they create more opportunities for semiconductor technology change. Innovation capabilities will be a key competitive advantage. Strategic design wins will allow chipmakers to customize unique products for specific customer needs.

As innovation and R&D take priority, there are signs that companies are getting better at this. When asked about the biggest issue facing the semiconductor industry over the next three years, "rising R&D costs" dropped 19 percentage points from last year's survey, moving from first to third place.

Semiconductor R&D spending reached record levels in 2019, and respondents expect it to increase further in the coming year. However, the majority (58%) of respondents said they have successfully aligned R&D spending with market opportunities and leveraged new approaches such as agile portfolio management to get greater value from R&D spending. To learn more about R&D efficiency, see Part 1 of the Global Semiconductor Industry Outlook 2020.

Turning ideas into reality requires specialized talent. Talent development and management tied for second place among industry strategic priorities in this year’s survey. A war for talent is underway as companies compete for a small cadre of scientists and engineers with the skills to develop innovative products that underpin emerging technologies, including the Internet of Things (IoT), artificial intelligence (AI) and self-driving cars.

Achieving faster speed to market is also a major concern. It tied for second among strategic priorities, up 12 percentage points from last year. Important growth drivers are already emerging for the Internet of Things, 5G, and autonomous vehicles. They are already driving revenue share gains for the semiconductor industry, and this trend will continue for many years. For example, automotive semiconductors represent a $200 billion end market by 2040. Developers of these emerging technologies need new, advanced chips that are specifically designed for a range of new applications, from smart home devices to self-driving car systems. It is critical to bring products to market faster than competitors. IHS Markit predicts that by 2020, global semiconductor industry revenue will increase by more than $25 billion, driven primarily by sales of 5G smartphones.

These customers will become an important part of the future semiconductor industry. Chip manufacturers must meet their needs before their competitors do, or risk missing out. As a result, the pressure to achieve R&D prototypes and design wins is increasing.

Strategic priorities for semiconductor companies over the next three years

“As the semiconductor industry transforms across markets, customers and the supply chain, meeting customer demands and remaining competitive requires cutting-edge innovation and securing the right talent.”

-Lincoln Clark, Partner, Global Semiconductor Practice, KPMG LLP (US)

Mergers and acquisitions accelerate diversification

Chipmakers are gearing up for growth again as the semiconductor industry recovers from a revenue slowdown in 2019. They are refocusing on increasing scale and proficiency in core capabilities and expanding into new features that increase revenue.

Mergers, acquisitions, and joint ventures will be a key part of their strategy. As a group, they are ranked as a top three priority for nearly a third of semiconductor companies. In addition, 70% of semiconductor executives expect their companies to conduct some kind of major transaction in the next three years, while only 30% plan no transactions or divestitures. IDC expects market consolidation to begin earlier, with deals focused on growth technologies such as the Internet of Things, automotive, and artificial intelligence. Chipmakers plan to conduct M&A activity to achieve four main goals: acquire new capabilities, improve current core competencies, enter new markets, and enter adjacent markets. The preferred method of transaction is influenced by company size.

Small and midsize companies, with less than $1 billion in annual revenue, are more focused on entering new markets than their larger counterparts. Midsize companies, in particular, are interested in deals that provide them with new capabilities.

Large companies with annual revenues of $1 billion or more are more likely than smaller companies to pursue deals that help them expand into adjacent markets. We can see evidence of this by looking back at Intel’s $15 billion acquisition of autonomous vehicle software company Mobileye and Broadcom’s $18 billion acquisition of enterprise solutions company CA Technologies. Given their typically higher maturity and broad portfolios, large companies are nearly twice as likely as smaller companies to divest non-core assets over the next three years.

Current geopolitical trends are also influencing the M&A outlook for the industry. China's vision to develop an indigenous chip business, coupled with the U.S. goal to protect technologies deemed critical to national security, are integral factors. Chinese companies are focusing on organic growth, driven primarily by domestic R&D investments. At the same time, current U.S. policies prevent most M&A activity with Chinese companies. As a result, Chinese companies are unlikely to actively participate in the bidding process when semiconductor assets are sold. With fewer bidders pushing up prices, overall valuations are stabilizing. Seller expectations are becoming more moderate and reasonable, directly benefiting M&A buyers.

Strong revenue growth prospects, lower borrowing costs, and otherwise positive capital market conditions will also help. Companies want to have cash on hand, and they are willing to pay for assets that allow them to diversify their businesses into new growth areas.

Types of M&A and/or divestiture activity by conductor companies over the next three years

“To capitalize on the convergence of megatrends such as IoT, 5G, AI and autonomous vehicles, companies should be prepared to pay higher multiples for assets that can unlock value in existing portfolios. This will require a different approach to M&A than the integration approach companies have traditionally taken.”

——Scott Jones

Head of Global Semiconductor Practice, KPMG (USA)

New talents are needed in the future

The demand for semiconductor talent is an important result of the emphasis on innovation and R&D. In the current environment where M&A levels are low and companies are not expanding R&D capabilities through M&A, internal talent development is critical. Lower M&A levels require companies to focus more on internal innovation, while in periods of high M&A activity, companies are actually buying talent, intellectual property (IP) and R&D capabilities.

Winning the future in semiconductor research, design and manufacturing requires access to top high-tech talent. Realizing growth opportunities in new, untested areas relies on talent to turn concepts into reality. Chipmakers are actively seeking scientists and engineers with unique skill sets who are capable of developing advanced semiconductor products for a variety of applications, including the Internet of Things, 5G, artificial intelligence and autonomous vehicles. Software developers are also in high demand as chipmakers move to more service-oriented business models that meet a wider range of customer needs and capture a larger share of revenue.

However, global competition for talent is fierce. Compared with last year's survey, talent development and management ranked second among strategic priorities and has received increasing attention from semiconductor executives. In addition, talent risk was the second largest industry issue mentioned by all respondents and ranked first (by far) among small company respondents with annual revenues below $100 million.

Companies are struggling to add staff to keep up with growth patterns, but the high-tech resource pool is thin. In the United States in particular, the shortage of science, technology, engineering, and mathematics (STEM) talent is becoming a crisis: the number of U.S. STEM jobs is expected to grow dramatically, but millions of positions could go unfilled due to a lack of qualified candidates. Universities around the world—and especially in the United States—simply aren’t producing enough STEM talent. Other countries, led by India and China, continue to outpace the United States in awarding science and engineering degrees.

Startups and small businesses in particular struggle to compete for limited talent resources. Established organizations can often offer higher salaries and better benefits. Companies are also increasingly focusing on the “employee experience” and becoming a preferred workplace. Innovative office designs, flexible and remote work arrangements, and company culture play an increasingly important role today.

In addition, tech giants and platform companies are getting into the chip business, and as leading global players, they are often very attractive employers. They are increasingly attracting the best and brightest scientists and engineers from the traditional semiconductor industry to join their ranks. According to our survey, one of the main impacts of tech giants developing their own chip capabilities is that talent is becoming increasingly difficult to retain.

The biggest problem facing the semiconductor industry in the next three years

To position themselves for continued growth, it will be critical for semiconductor companies to close the talent gap. As the workforce changes, existing employees will need to upskill and re-adapt to new demands. Companies are rethinking their organizational designs to best prepare for sustainable growth and considering developing career paths to best account for the journey from employment to retirement.

They don’t have to do it alone. Chipmakers can work with government agencies and industry associations to address the talent shortage. By collaborating on proactive measures—such as pooling resources to ensure more strategic investments in STEM education and creating more opportunities for high-tech trainees to gain on-the-job experience through internships, apprenticeships and other programs—the industry can prepare for the future.

Research funding is another key component of developing the talent pipeline. The Semiconductor Industry Association (SIA) is calling on the federal government to triple investment in semiconductor research, not only to develop new materials and designs, but also to grow America’s innovative workforce.

Territorialism and tariffs

Territorialism is actually tied with talent management (37% vs. 36%) as the industry’s top concern. Managing new financial and operational risks from new cross-border tariffs and regulatory measures is a growing challenge for semiconductor companies. These measures include U.S. tariffs on imported electronics, automobiles, and other consumer and industrial products containing semiconductors, and China’s counter-tariffs on similar U.S. imports.

As tariff disruptions cause cost pressures in the industry, semiconductor companies must make difficult financial choices, including whether to absorb the additional costs or pass them on to customers. The supply chain is also feeling the impact, as chipmakers and their customers are considering switching to suppliers or manufacturing locations that are not subject to tariffs in order to reduce tariff risk. To learn more about the impact of tariffs on the semiconductor industry, see Part 1 of the Global Semiconductor Outlook 2020.

As tech giants and platform companies continue to develop their own chips and silicon capabilities, what do you foresee as the main impacts on your organization over the next three years?

*Disclaimer: This article is originally written by the author. The content of the article is the author's personal opinion. Semiconductor Industry Observer reprints it only to convey a different point of view. It does not mean that Semiconductor Industry Observer agrees or supports this point of view. If you have any objections, please contact Semiconductor Industry Observer.

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